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Pension freedoms – what’s the catch?

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From 6 April, savers face far fewer restrictions on how they use their pension pots from the age of 55, being able to dip into their pension fund or withdraw all their money in one go. It is also much easier to take their 25% tax-free element in small instalments over time rather than as an upfront lump sum. But with the greater freedoms come risks that savers need to be aware of.

Caveat emptor – buyer beware

While this will give welcome choice and flexibility to pensioners, the potential dangers are huge. Experts have warned that many people may use up their cash too quickly, leaving them without enough savings to last the rest of their lives and reliant solely on the state pension.

Others will not understand the tax implications of withdrawing large sums of money and will end up end up paying a hefty bill to the HMRC. There are already reports of cold callers using the new rules to encourage people to move their money into high-risk or even fraudulent investment schemes.

Pension liberation scams are also expected to increase, as dodgy firms attempt to convince people they can cash in their retirement savings before they are 55, which can result in a massive tax penalty of more than 55% of the fund's value.

The Government has made a free guidance service available, called Pension Wise, offering face-to-face and telephone sessions, backed up by online information, to help you to understand your options. But guidance has its limits – Pensions Wise is not able to recommend a course of action or tell you which products to use. Professional financial advice could be a worthwhile investment for many people, but many will be put off by the cost. However, making the wrong decision could be far more expensive in the long run.

Gareth Smith, pensions support manager at Skipton Financial Services Limited said, “There’s no doubt that the pension changes – whilst offering great opportunities – make the decision over how to utilise your pension fund a more complex one. There are no easy answers, but you can’t allow that to put you off reviewing and making plans.

“A financial adviser can offer specialist advice and help you to devise and implement a retirement plan. Even if you have never used the services of a financial adviser before, this is one occasion to seriously think about doing so.”

Annuity sales have halved in the year since the 2014 Budget, when the changes were announced, while the share price of major annuity providers plunged after the Chancellor announced the changes in his Budget last March, demonstrating how important the annuity market is for insurers.

Annuities still have a role to play

According to Hargreaves Lansdown, an advice firm, there is an estimated 200,000 to 400,000 people waiting to take advantage of the new freedoms in the first weeks and months after 6 April.

But while there has been a backlash against the annuity market, which critics say has given customers a poor deal for too long, pensioners with modest savings should not automatically ignore consider the benefits these products could offer. According to the Association of British Insurers, the average pension pot of those buying an annuity is £36,600. This would typically buy an income of around £2,000 per year for an average 65 year-old, although enhanced annuities offer higher incomes for smokers and those with health problems.

David Smith, financial planner at Tilney Bestinvest, says: "Annuities will still be the best option for many people because they provide a guaranteed income for life."

For those who do not wish to buy an annuity, but would rather draw down an income over time, they will need to make sure that their pension provider can offer this accessibility and that the costs are not too high.

David from Bestinvest says this option is more likely to be suitable to pensioners with larger pots of at least £50,000. He says that there are many competitively-priced self-invested personal pensions and other flexible pensions that savers can transfer to if their current provider does not offer a good deal, with drawdown products offering no set-up or withdrawal charges coming onto the market.

If opting for drawdown, make sure you don't leave yourself liable for a surprise tax bill. Remember that only 25% of your pension pot can be taken tax-free – either your initial lump sum or 25% of each withdrawal, with the rest taxed as income, subject to the marginal rate of tax, depending on how much you take.

 If you have plans to withdraw a substantial sum, or cash in your whole pension pot, this could push your income into one of the higher tax bands.

“I plan to live for today, with an eye on tomorrow”

Andy Williamson, 56, from Fife plans to continue working in his role as a maintenance trainer until he is 65 and make use of the new freedoms to release money in the mean time. His wife Peggy, 53, has multiple sclerosis and has already had to retire because of the condition. Andy wants to withdraw all of his tax-free cash now and release further funds through staggered withdrawals over time. "We want to use the money to take a trip somewhere warm like the Canary Islands as the heat is good for Peggy, and also to make adjustments to our home," he explains. "We would also like to help our four daughters with their housing and other costs."

Mr Williamson says his pension is too small to provide a realistic income in retirement. As a couple they hope that they may inherit enough to live on – although it is worth pointing out that Wills can be changed and inheritance is not something you can rely on. "I lost my Dad at 61 and he had so many plans that he wasn't able to see through. I plan to live for today, with an eye on tomorrow," he says.

This article has been commissioned by retiresavvy and any opinions voiced are the author's own.

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